Profit From Customer Loyalty With These 7 'Sin Stocks'

After reading through hundreds of press releases in the just-completed earnings season, I'm not surprised that CEOs are quite excited about their company's prospects. However, with every company putting a positive spin on its operations and outlook, it can be hard to separate the wheat from the chaff.

One distinguishing factor: the executives and directors who back up their words with actual insider buying. Committing thousands of dollars to buy company stock is a huge vote of confidence.

Throughout the past winter, insider buying activity was relatively dormant as an ever-rising market led most insiders to think about cashing in options rather than buying fresh shares. Yet in the past month, we've seen a notable upturn in insider buying activity.

1. Walter Energy (NYSE: WLT)
Though the long-term prospects for coal remain troubled, some investors see a solid near-term trading opportunity as increased power plant burning of coal is expected to lead to firming prices.

I recently noted that trading window, suggesting that analysts were keen on CONSOL Energy (NYSE: CNX) and Arch Coal (NYSE: ACI), but insiders are pointing the way toward value at coal producer Walter Energy. In the past few weeks, 11 of them have acquired a collective 114,000 shares at an average price of $18.

Whereas CONSOL and Arch Coal are focused on thermal coal, Walter Energy is more focused on "met" coal, which is used in steelmaking and other applications that require intense heat. And while the near-term outlook for thermal coal is seen as brightening, the longer-term outlook for met coal is more robust, especially as steelmaking picks up.

Analysts at Citigroup think "met coal contract pricing will rebound in 4Q, and we see WLT being a primebeneficiary given their heavy met mix." They see shares rising from a recent $19 to their $29 target price. That's cold comfort for investors that have held this stock all the way down from $140 in early 2011, but it represents nearly 50% upside from here.

As I noted in that article, sales growth has evaporated recently, but analysts expect growth to resume in 2014. After watching this stock fall from $16 in early 2011 to a recent $8, a pair of company directors purchased a collective 40,000 shares at an average price of $7.90.

3. Kratos Defense (Nasdaq: KTOS)
Insiders have been snapping up shares of this defense contractor for much of the past 18 months, with a fresh cluster of buying between March and May this year. Shares have been stuck in the $4 to $6 range that whole time, but signs of a breakout are emerging.

Frankly, the early bouts of insider buying now look premature. That's because management has had to clean up the mess created by a series of acquisitions. Integrating the acquired defense and security contractors bled a considerable amount of free cash flow, but management believes the process is now complete and expected free cash to start rising at a solid pace in coming quarters.

Kratos is involved in a variety of industries -- from building security to surveillance to missile technology to cybersecurity -- so investors may have a hard time assessing the company's core growth prospects. Instead, it's the focus on free cash flow, which may exceed $40 million this year (on a $1 billion revenue base) that will attract investors to this beaten-down stock. At least that's what insiders are counting on after spending hundreds of thousands of dollars on company stock in recent quarters.

Risks to Consider: Insiders have notoriously bad timing and sometimes reflect bullishness a few quarters before it is warranted, so don't expect quick gains in these stocks.

Action to Take --> These stocks have seen solid levels of insider buying -- after shares have fallen far from multi-year highs. In a market environment of fewer obvious bargains, these stocks are worthy of further research.

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